Jason's World

It was a moment that a lot of bears have seen coming.

Investors got a wake-up call from the AI euphoria that has been widespread over the past few weeks as Chairman Jerome Powell and the Bank of England led a hawk kettle’s collective screech that roiled global markets. The Bank of England raised interest rates by half a point as opposed to the 25 basis points that was expected by investors.

It was the market’s worst week since the onset of the March banking crisis as central banks around the world maintain an aggressive posture against global inflation that has begun to weigh on the world economy.

Even amidst the general hype over artificial intelligence, warning signs flashed throughout the week that suggest that euphoric investors may be in for a reality check.

Business expansion in Europe grinded to a halt even as supply chain issues have eased since last year as the impact of high interest rates in Europe begin to bite. The ECB has raised its target rate from 0% to 4% throughout the last 10 months, however inflation remains stubbornly high, much higher than that of the United States. Inflation in the eurozone remains at 6%. This suggests that the economic situation in the eurozone, which represents about a seventh of the global economy, has a lot of potential to worsen further as the ECB would likely decide that the rate hikes so far are insufficient to meaningfully combat inflation even as business growth comes to a near standstill.

A cloud of uncertainty hovers over US investors as there seems to be mixed signals concerning how far to increase interest rates from this point. During Chairman Powell’s testimony on Wednesday, he was rather ambiguous about where he thought rates should be, and there remains a few members of the FOMC that insist more that the two hikes that Powell hinted at during the FOMC meeting might be needed.

It is true that the economy, and with it the stock market, was defying many of the expectations of economic malaise this year. Though it is unlikely that the US economy will escape recession forever, a nascent AI rally that began last month as well as improving economic projections have fueled new hopes that the markets would shrug off any potential downturn if one happens at all. 

However, the risks in equities markets remain extremely high. The impact of interest rates on the economy may not be fully felt as of now, as it may take at least a year for interest rates to have a meaningful impact on the economy. The fact that more people are working multiple jobs than in years past should raise questions about whether recent job reports are as good as many believe them to be. 

In the coming months, we should expect to see more of the effects of the rate hikes, because a year ago, the Fed was only in the beginning stages of its rate hike campaign. It probably explains why the Fed decided to pause at its recent meeting; a year has passed since the Fed began hiking rates in earnest, and the true impact of these hikes may just be rearing its head right about now. 

And since tech companies are more prone to the effects of rate hikes than any other industry not just in terms of stock prices, but also in terms of interest that needs to be paid as the industry is heavily debt-fueled, it seems like the AI rally may be on pause for a while as investors are likely to rotate out of tech amidst wariness about sky-high valuations and tight conditions. We may very well come to remember the past month as the AI bubble that never was, since it lasted for such a short time compared to the dot-com bubble, especially if the hawks get their way, and if there are more signs in the coming months that the economy may not be as resilient in the face of hikes after all.